Feb. 10, 2013
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Traders gather on the floor of the New York Stock Exchange. / Richard Drew, AP

by Adam Shell, USA TODAY

by Adam Shell, USA TODAY

NEW YORK - Bull markets often die when stocks are richly valued. But this bull is still in the valuation sweet spot.

The bull market that began four years ago has pushed stocks up 124% and near record highs. But what the big rally hasn't done is cause stock valuations to hit nose-bleed levels that put the bull market at risk, says Jeffrey Kleintop, chief market strategist at LPL Financial.

The market, which stalled last week at levels last seen near the stock market's 2007 peak, rose 0.6% on Friday. The consensus on Wall Street is that the market is prone to a 3% to 5% pullback, notes Chris Verrone, an analyst at Strategas Research Partners.

Currently, the Standard & Poor's 500-stock index is trading at a price-to-earnings ratio of just 14.9, based on the index's trailing four-quarter earnings. That is below the 18.8 average since 1998. It is also significantly lower than the peak P-Es in the prior five bull markets in the post-World War II era, which include a P-E of 16.8 in the 2007 bull and a 28.2 P-E at the market peak in 2000.

"There might be some ups and downs, but we will likely have another leg up in this bull market," says Kleintop. "Bull markets end at higher stock market valuations."

Indeed, if the massive rally that began in March 2009 suddenly ended at today's below-average valuations, it would mark the lowest P-E at any bull market peak in the last six decades, according to data Kleintop compiled.

The market's attractive pricing relative to history is a big reason why Kleintop believes the multiyear rally has more room to run even if it stumbles from time to time. He says any market pullback should be viewed as a good time to buy rather than a warning sign that the big run-up is over and a bear market is looming.

However, Kleintop warns that the market might have a hard time moving higher right now as it digests the Dow Jones industrial average hitting 14,000 this month for the first time since October 2007. His research shows that the Dow has had difficulty rising in recent years after hitting key milestones.

The Dow, for example, hit 11,000 in April 2010, but was not able to break free of that big, round number until November of that year. Similarly, after topping 12,000 in February 2011, the blue-chip gauge didn't break out above that milestone until December 2011. And last year the Dow hurdled 13,000 in February as well, but went sideways for 10 months.

Still, low valuations suggest the market can rise higher even if the market suffers a similar pause in 2013.

"The pattern may be repeated this year," says Kleintop. "However, the bull market is not likely to be over. If so, stocks would be ending a bull market with the S&P 500 priced at its lowest multiple of earnings for a bull market since WWII."

Paul Hickey, co-founder of Bespoke Investment Group, agrees that low valuations will provide nice support for the stock market.

"A point that bears repeating is the fact that just because the Dow or S&P 500 hits a multiyear high doesn't necessarily mean that the market immediately pulls back," Hickey says. "One of the biggest positives in our view is the fact that valuations are still attractive."

Hickey says if the S&P 500 were trading around a similar valuation to the one it traded at the last time it was above 1500 in late 2007, the S&P 500 would need to rally about 12% and climb above 1700.